Unitary investment having interrelated assets

ABSTRACT

The present invention provides a unitary note investment instrument and method of use that has two performance components. An investor invests in the issuer the principal amount of the investment. The first component is a base portfolio. The second component is keyed to a passive commodity index, having long and short positions. The instrument&#39;s commodity index exposure is established as the product of a leverage factor of at least 100% and the amount of the base portfolio exposure. The return to the investor comprises the change in value of both the base portfolio exposure and the commodity index exposure over a predetermined period of time multiplied by a payout factor.

REFERENCE TO RELATED APPLICATIONS

This application is a divisional patent application of U.S. patentapplication Ser. No. 09/267,186 filed on Mar. 12, 1999 now U.S. Pat. No.6,856,971.

TECHNICAL FIELD OF THE INVENTION

The present invention pertains in general to financial investments andin particular to such investments which base their return on acombination of notional portfolios through which market exposure isacquired, and adjusted as indicated by a predetermined mathematicalformula, through the use of derivatives, thereby permitting a multipleutilization of capital.

BACKGROUND OF THE INVENTION

Financial products have increasingly emphasized the value ofdiversification. Modern Portfolio Theory has demonstrated that over timea diversified portfolio, by reducing the incidence of major drawdowns,can generate high cumulative returns with reduced volatility (acommonly-used measure of risk), as compared to conventional portfoliosconsisting of stocks and bonds. “Non-traditional” investments areincorporated into an investment strategy because they are likely todemonstrate a significant degree of performance non-correlation to a“base portfolio,” typically the general equity and/or debt markets. Bycombining non-traditional and traditional portfolio components, an“efficient frontier” of investment performance can be developed in whichthe addition of the non-traditional component increases returns whilealso reducing volatility up to the point of the desired level ofportfolio efficiency (risk/reward ratio) and maximum non-traditionalexposure.

One of the difficulties in implementing the diversification strategy ofModern Portfolio Theory has been to identify a reliably non-correlatedand positively performing non-traditional investment instrument orclass. Diversifying into a non-traditional investment can reducevolatility but not ultimately benefit a portfolio if the non-traditionalinvestment is not profitable. In addition, many non-traditionalinvestments have not, in fact, proved to be non-correlated with thebroader markets, especially during periods of market stress (when therisk control benefits of diversification are potentially of the mostimportance).

Modern Portfolio Theory was developed in the 1950s. In the early 1960s,published financial portfolio research demonstrated that managed futuresmight serve as a non-traditional “asset class” for purposes ofdiversifying a traditional portfolio in a manner consistent with thetenets of such Theory. Since that time, while futures/commodities havebeen increasingly accepted as a means of diversifying traditionalportfolios, the dominant approach to incorporating futures into aportfolio has focused on the use of managed futures—futures accountsactively managed by professional “Commodity Trading Advisors” and“Commodity Pool Operators.” The futures markets provide efficient andleveraged access to a wide range of potentially non-correlated assets.However, the performance of managed futures products has beenunreliable. Whether managed on a discretionary basis or pursuant tocomputer models, actively managed futures strategies have demonstratedsignificant periods of under-performance. Furthermore, even when amanaged futures investment is successful, it is impossible to predictwith any confidence what its likely near- to mid-term performance willbe. This uncertainty means that it is impossible to know whether anygiven non-traditional investment will be (1) profitable and/or (2)non-correlated with an investor's base portfolio.

A related impediment to the efficient implementation of Modern PortfolioTheory investment products through the use of non-traditionalinvestments is that non-traditional investment portfolio managerstypically regard both their strategies and their market positions asproprietary and confidential. Uncertainty of performance is combinedwith uncertainty as to holdings and methods of strategy implementation.These uncertainties have caused many institutions (especially thosewhich believe that their fiduciary obligations to their investors orbeneficiaries require that they have access to position data) to avoidnon-traditional investments. The “entry barrier” of not providing tradetransparency is heightened because most actively managed non-traditionalstrategies are subject to a non-quantifiable “risk of ruin”—thepossibility of sudden and dramatic losses of a large percentage of anoverall portfolio. In today's market environment, this is a particularlytopical concern due to the massive and wholly unexpected losses sufferedby a number of non-traditional, “hedge funds” in 1998, many of which hadpreviously exhibited excellent risk/reward characteristics. “Risk ofruin” is not generally considered to be a component of traditionalequity and debt investments, and can be best monitored by “real time”knowledge of strategies and positions.

Finally, non-traditional investment alternatives are frequently highlyilliquid. Many non-traditional strategies have a statisticallysignificant incremental likelihood of success the longer the timehorizon of the strategy cycle. This is especially the case with relativevalue, quasi-arbitrage methodologies but is characteristic of manynon-traditional approaches. As a result, many non-traditionalinvestments require investment commitments of 12 months or longer,eliminating investors' ability to limit their losses or adjust portfolioexposure by terminating or reducing their investment.

The present invention provides a non-traditional investment instrumentwhich eliminates the illiquidity and trade non-transparency of manyalternative non-traditional investments and which has producedconsistently successful and non-correlated performance over 37 years ofresearched price histories.

SUMMARY OF THE INVENTION

A selected embodiment of the present invention is a unitary investmentswap instrument. The swap creates a notional performance portfolio,based on a substantially smaller amount actually deposited ascollateral, which represents a multi-asset portfolio and determines thereturn to the investor over a predetermined period of time. Theperformance portfolio, at the initiation of the predetermined timeperiod, comprises a base portfolio, which may be equity based, and apassive commodity index portfolio, of long and short positions. Thepassive commodity index portfolio creates an exposure in an amountsubstantially equal to the product of the base portfolio exposure amountand a leverage factor, which together define a commodity index portfolioexposure. The commodity exposure may be subject to periodic adjustment.The return to the investor comprises substantially the change in valueof both the base portfolio exposure and the commodity index portfolioexposure over the predetermined period of time. The investor may alsoreceive interest earned on the collateral deposit.

A further embodiment of the present invention is a unitary investmentnote instrument which includes an investment principal amount that isinvested in the instrument. A predetermined maturity date defines thetime period over which the change in a notional performance portfolio ismeasured. The change in value of the performance portfolio, reduced bythe application of a payout factor, determines the return to theinvestor for the instrument. The issuer of the note guarantees that theinvestor will receive back at least the amount of the investmentprincipal at the end of the term. The performance portfolio, at theinitiation of the predetermined time period, comprises a base portfolio,which may be equity based, having an exposure in an amount substantiallyequal to the investment principal and a passive commodity indexportfolio, of long and short positions. The passive commodity indexportfolio creates an exposure in an amount substantially equal to aproduct of the base portfolio exposure amount and a leverage factor,which together define a commodity index portfolio exposure. The returnto the investor, in addition to the investment principal, comprises theproduct of (1) substantially the change in value of the base portfolioexposure and the commodity index portfolio exposure over thepredetermined time period and (2) a payout factor, which is typicallyless than one.

BRIEF DESCRIPTION OF THE DRAWINGS

For a more complete understanding of the present invention and theadvantages thereof, reference is now made to the following descriptiontaken in conjunction with the accompanying drawings in which:

FIG. 1 is a block diagram illustrating a swap instrument in accordancewith the present invention,

FIG. 2 is a block diagram illustrating the rebalancing and leverageadjustment mechanism of the swap instrument,

FIG. 3 is a block diagram illustrating a note instrument in accordancewith the present invention, and

FIG. 4 is a block diagram illustrating the leverage adjustment mechanismof the note instrument.

DETAILED DESCRIPTION

The preferred embodiments of the present invention utilize twowell-established and independently maintained financial indices(although it is not necessary that a financial index be used as thebenchmark). These are the Standard & Poor's 500 Stock Index (referred toas the “S&P”) of large capitalization U.S. stocks and the Mount LucasManagement Commodity Index (referred to as the “MLM”). Those skilled inthe art will recognize that other indices can be used. For example, theS&P Diversified Trends Indicator (“DTI”) can be substituted for the MLMas used herein.

The S&P is a widely-used index. It is employed in the preferredembodiments of the present invention rather than the (at least) equallyfamiliar Dow Jones Industrial Average due to the significantly greaterliquidity of derivative instruments available on the S&P. This liquidityis important to the design of instruments of the present inventionbecause the banks and dealers which may issue these instruments reflectmarket liquidity (which, in turn, is directly reflected in the costsincurred by such banks and dealers in hedging their risks under thepresent invention instruments) in the pricing of such instruments. Thehigher the hedging transaction costs imposed on the issuers of thesubject instruments, the lower the efficiency of these instruments tothe investor.

The MLM tracks 25 different commodities/futures including 6 currencies,3 U.S. bonds and 16 traditional commodities (collectively, the “MLMObjects”). The MLM is an unleveraged index which has been analyzed over38 years of price histories and has been used to manage institutionalaccounts since 1993. It is comprised of long and/or short positions ineach of the 25 MLM Objects, each with an equal dollar value, rebalancedmonthly (this internal rebalancing of the MLM is not to be confused withthe rebalancing of the base portfolio exposure of the swap instrument byadjusting that exposure to reflect the performance of both the base andpassive commodity index portfolios, see below). All MLM positions areestablished as long or short on the basis of a straightforwardtrend-following model as of the beginning of each month and held untilmonth-end; no trades occur intra-month. A long position is taken if thecurrent spot price is above the average month-end spot price during thepast 12 months (indicating an upward price trend); otherwise a shortposition is taken. There is no discretionary input into the MLM;consequently, it can be mathematically applied to historical market datato generate researched price histories.

The MLM does not function as an all long commodity price index. On thecontrary, because it acquires both long and short positions in thevarious MLM Objects, the performance of the MLM is substantiallynon-correlated to overall commodity prices, adding a further dimensionto the diversification of the instruments of the present invention.

The present invention creates, not by active management but by theapplication of a passive index, a non-traditional portfolio componentwhich has a statistically high likelihood of both non-correlation totraditional market indicators and superior performance. The MLM is anunusual type of passive index in that unlike the standard commoditiesindices—the Commodity Research Bureau Index and the Goldman SachsCommodity Index—the MLM takes both long and short positions in thedifferent MLM Objects. In historical simulations, as well as actualinstitutional account performance since 1993, the results of the MLMhave substantially outperformed the all-long commodities indices as wellas exhibiting significantly greater diversification effects whencombined with the S&P. Certain combinations of the MLM and the S&P,mathematically adjusted on a periodic basis pursuant to the presentinvention, have yielded returns and risk control parameterssubstantially superior to either index (S&P and MLM) considered on astand-alone basis as well as substantially superior to many alternativecombinations of non-traditional and traditional investments.Furthermore, due to the liquidity of the MLM Objects and the resultingease with which the MLM can be hedged, the present invention can beprovided by a large number of different banks and dealers on competitiveeconomic terms.

An index of the type represented by the MLM is referred to herein as apassive, long and short, commodity index. The essential aspects of suchan index are that (1) it is primarily based on commodities, (2) it ispassive, which means it is determined by a formula rather than activemanagement, and (3) it takes both long and short positions.

The use of a passive index eliminates any uncertainty as to how theinstruments of the present invention will perform under any given marketscenarios while also allowing total transparency of trading positionsand strategies. In addition, the present invention is able to adjust toa wide range of different end-user risk/reward tolerance levels bypermitting wide flexibility in adjusting both initial leverage and theratio of base portfolio exposure to passive, long and short, commodityindex portfolio exposure. Once initially calibrated, instruments of thepresent invention perform robotically in accordance with the performanceexposure and risk components designed into the initial parameters.

Investment instruments pursuant to the preferred embodiments of thepresent invention are internally diversified when considered as astand-alone (unitary) investment, each combining the S&P and the MLM. Inaddition, the overall investment represents a diversification fromtraditional portfolio components.

Investors may redeem investments of the present invention at any time(subject to the possible imposition of a redemption charge in the caseof the note investment instrument). The ability to redeem combined withtotal trade transparency provides investors with a layer of risk controlunavailable in most non-traditional investment alternatives.

Because of the passive character of the indices incorporated in thepresent invention, it is also possible to fix the costs applicable tothese instruments at the time each instrument is designed. Changes inmarket conditions subsequent to product inception have no effect on thepricing to the investors. This eliminates the risk that a materialincrease in market volatility (and, accordingly, the hedging cost to theissuer of an instrument of the present invention) will result in acommensurate increase in embedded costs, and corresponding degradationof investment potential. Actively managed non-traditional investments,on the other hand, can be subject to extreme variability of costs, afeature which is especially unacceptable to institutional investors whenthey are denied access to the trade information necessary to monitor theactual level of transactions being executed.

The performance of the MLM cannot be predicted in the abstract; however,given any assumed market movements, this performance can be determinedwith high probability. This enables investors to apply marketsensitivity analysis—a basic method of quantifying market riskexposure—to the positions held by the instruments of the presentinvention with a high degree of accuracy. On the other hand, it is notpossible to conduct reliable market sensitivity, “value at risk” orMonte Carlo simulation market exposure analysis on most actively managedalternative investment products. The “risk of ruin” in instruments ofthe present invention can be clearly quantified; in most non-traditionalinvestments it is effectively unknowable.

Statistical analysis also indicates a remarkably high degree ofnon-correlation between the S&P, as well as overall debt market indices,and the MLM throughout a wide range of different market cycles.

The use of the MLM in combination with an investor's base portfolioaddresses many of the difficulties encountered to date in incorporatingnon-traditional investments as a “mainstream” component of traditionalportfolios.

FIGS. 1-4 generally indicate a progressive time period going from thetop to the bottom of each Figure. The base portfolio exposures andpassive, long and short, commodity index portfolio exposures areseparated horizontally although they are part of the unitary investmentinstruments of the present invention.

Referring to FIG. 1, there is illustrated a swap instrument 20 inaccordance with the present invention. An investor who wishes to utilizethe swap instrument 20 provides a collateral deposit 22 having aspecified dollar value. This collateral may be deposited in the fullamount of a base portfolio exposure 24 or in a greater or lesser amountas negotiated between the swap issuer and an investor or a managerrepresenting the investor.

The return provided to the investor is measured by a notionalperformance portfolio which comprises the base portfolio exposure 24 anda passive, long and short, commodity index exposure 26. The face amountof the base portfolio exposure 24 is identified by the term P₁. The faceamount of the passive commodity index exposure 26 is the product of aleverage factor L₁ and the base portfolio exposure P₁.

The leverage factor L₁ is determined by a formula that is based on theperformance of the selected commodity index used for the commodityexposure 26. If the commodity index performance in the preceding 12months (or other period of time) equaled or exceeded 15% (in the case ofthe MLM under market conditions in late 1998; using a differentcommodity index and/or under different market conditions, this figurecould vary from 15%), L₁ is selected to be 150%, but if the totalperformance of the selected commodity index is less than 15% during thepreceding 12 months (or other period of time), the leverage factor L₁ isselected to be 300%. These are preferred leverage factors, but otherleverage factor values may also be used.

The swap instrument 20 includes a predetermined time period 30 whichpreferably is one year. Typically, the instrument 20 is not terminatedat the end of one year, but is reset as further described with referenceto FIG. 2.

The initial performance portfolio for the swap instrument 20 comprisesthe base portfolio exposure 24 and the passive, long and short,commodity index exposure 26. After the time period 30 has elapsed, thefinal performance portfolio comprises a base portfolio exposure 32 and apassive, long and short, commodity index exposure 34. The base portfolioexposure 32 has two components which are the original exposure 32 a anda value change 32 b. Likewise, the commodity index exposure 34 has anoriginal component 34 a and a value change 34 b.

The return for the time period 30 has two components. The firstcomprises the value change 32 b which is expressed as the term ΔV_(B1).The passive, long and short, commodity index exposure 34 has a valuechange 34 b which is expressed as the term ΔV_(C1). Thus, the return onthe swap instrument 20 for the time period 30 is represented by the sumof ΔV_(B1) and ΔV_(C1). Should the instrument terminate at the end ofone year, the investor would receive back the amount of the collateral(which may or may not be equal to the base portfolio exposure 24), plusinterest (if applicable) on such collateral, together with the totalchange in value represented by ΔV_(B1) plus ΔV_(C1).

The example shown in FIG. 1 represents a positive increase in value ofthe notional portfolio exposures 24 and 26. It is, of course, possiblethat the values of these exposures could decrease over time, and thevalue changes represented by the return for a given period could benegative. Such negative amounts would be paid to the instrument issuerfrom the collateral 22 deposited to initiate the swap. The collateral 22supporting the swap is not, however, the maximum which the investor canlose. Losses in excess of the collateral must be paid by the investor tothe swap issuer.

At the end of the time period 30, the swap instrument 20 is subject torebalancing as illustrated in FIG. 2. The rebalancing is optional inthat it occurs only if the instrument 20 extends beyond the first timeperiod 30. The rebalancing aspect is referenced as a swap instrument 20′in FIG. 2. The first step in the process of rebalancing the swapinstrument 20′ is to determine the net asset value (NAV) of theinstrument 20 at the end of the time period 30. This comprises the sumof the collateral deposit 22, the interest on this collateral deposit,and the value changes 32 b and 34 b. The sum of these four quantities(interest may, however, be paid out to the investor and, accordingly,equal zero for these purposes) becomes the rebalanced base portfolioexposure 44. Exposure 44 a comprises the collateral deposit and interest(if not paid out) and exposure 44 b comprises the value changes 32 b and34 b. The amount of base exposure 44 is represented by the term P₂.

A new passive, long and short, commodity index exposure 46 has a valuethat is the product of a new leverage factor L₂ and the rebalanced baseexposure value P₂. The leverage factor L₂ is determined in the samemanner as described above for the factor L₁, but calculated at the end,rather than as of the beginning (as in the case of the swap instrument20), of time period 30. The leverage factor L₂ has a value of either150% or 300% depending on the performance of the referenced commodityindex over the preceding 12 months (or other period of time). At the endof a time period 48 (time period 2), which may be of the same durationas the time period 30, the final performance portfolio comprises a newbase portfolio exposure 50 and a new passive long and short commodityindex exposure 52. The base portfolio exposure 50 has a base exposure 50a and a change in value 50 b. The commodity exposure 52 has a baseexposure 52 a and a change in value 52 b. The return for the time period48 is the change in value 50 b, which is expressed as the term ΔV_(B2),and the change in value 52 b which is expressed by the term ΔV_(C2),plus interest on the collateral deposited to support the swap.

The process illustrated in FIG. 2 can be repeated for as many timeperiods as desired wherein for a third time period the value change 50 breplaces the value change 32 b, the value change 52 b replaces the valuechange 34 b, and the base portfolio exposure 50 replaces the baseportfolio exposure 32. Typically, the swap instrument 20 will beselected to have a yearly time period for releveraging and rebalancingand a duration of 5-7 years.

A numerical example for the swap instrument 20, as shown in FIGS. 1 and2, is now presented. For this example, the collateral deposit 22comprises $10 million and is assumed to equal the amount of the initialbase portfolio exposure 24. Consequently, the base portfolio exposure 24comprises an stock index notional amount of $10 million. Assuming thatthe leverage factor L₁ is the high leverage factor of 300%, the notionalcommodity index exposure 26 is $30 million. Assume that at the end oftime period 30 the base portfolio exposure 24 increased in value by $1million and the passive commodity index exposure 26 increased in valueby $500,000. The value change 32 b would be $1 million and the valuechange 34 b would be $500,000. Therefore, should the swap instrument 20be terminated at the end of the first year, the return to the investorwould be $1.5 million and the investor would also receive back theamount of his collateral plus interest.

The rebalancing of the swap instrument 20′ is described with referenceto FIG. 2. The initial base portfolio exposure of the swap instrument 20plus the changes in value in the base portfolio and commodity indexportfolio at the end of the time period 30 was $11.5 million. Therebalanced base portfolio exposure 44 is set to be $11.5 million (ineach case, disregarding interest on the collateral deposit, which may bepaid out to the investor at the end of time period 30 and will vary withthe nature of the collateral deposited). This value is represented bythe term P₂. In the releveraging process, the leverage factor L₂ isrecalculated, based on the same formula used to determine L₁, theinitial leverage factor used to determine the initial commodity indexexposure, at either 150% or 300% (one “non-enhanced” mode of thisinvention applies a constant 100% leveraging factor). If 150% is theresult of the formula, the notional value of the rebalanced passive,long and short, commodity index exposure 46 is $17.25 million. It is$34.5 million if the 300% leverage factor is applied.

Continuing with this example, if at the end of the time period 48 theamount of the rebalanced base portfolio exposure 50 is $12 million, thenthe value change 50 b is $500,000. If the passive, long and short,commodity index exposure 52 has a final notional value of $18.0 millionand the 150% leverage factor was selected so that this exposure as ofthe beginning of the second time period 46 was $17.25 million, then thevalue change 52 b is $750,000. Thus, the return to the investor for theperiod 48 would be $1.25 million. The base portfolio exposure 32 a plusthe value changes 32 b and 34 b at the end of time period 30 would alsobe returned to the investor, plus interest.

The swap instrument of the present invention has a base portfolio, whichis preferably keyed to an equity index (which in the preferredembodiment is the S & P), and a passive, long and short, commodity index(which in the preferred embodiment is the MLM). The exposure to the MLMis calibrated based on the exposure of the base portfolio. Selectedleverage factors for the MLM with respect to the base portfolio can be,for example, 100%, 150% or 300%. Other leverage factors as well as othermeans of periodically rebalancing and releveraging the two portfolioscan also be applied. The diversification features of the unitary swapinstrument with these leverage factors using the S&P and MLM indices isillustrated below in Table I.

TABLE 1 SWAP INSTRUMENT MARKET SECTOR ALLOCATIONS Percentages Are ofTotal Portfolio Exposure S&P (Base Portfolio) Equities 50%  40.0% 25%MLM (Passive, Long and Short, Commodity Index Portfolio) 100% Leverage150% Leverage 300% Leverage Bonds 6%   7.2% 9% Currencies 12%  14.4% 18%Energy 8%  9.6% 12% Grains 10%  12.0% 15% Other Agricultural 8%  9.6%12% Metals 6%  7.2% 9% 100% 100.0% 100%

The swap instrument 20 is not a limited liability investment. In highlyunusual market environments, investors could be liable for margin callsin addition to the collateral deposit. This possibility, no matter howremote, may be unacceptable to many institutional investors.Consequently, an optional feature for the present invention has beenstructured in the form of a 5% “out of the money” put option offeredeither by the swap issuer or by a third party dealer, effectivelylimiting investors' maximum loss on the MLM component to 5% for eachunit (corresponding to the base portfolio exposure) of MLM leverageemployed. At current market rates (late 1998), the premium cost of thisoption is approximately 4.50% for each unit of MLM leverage used (6.75%at 150% MLM leverage or 13.50% at 300% MLM leverage). The worst case MLMloss would equal the loss of the premium (which is non-refundableirrespective of MLM performance) plus 5% on each unit of MLM leverageemployed, or 14.25% at 150% MLM and 28.50% at 300% MLM. Accordingly,unless the S&P (or other base portfolio) component declined by more than85.75% or 71.50%, respectively, no additional margin payments would berequired (assuming the base portfolio exposure had been 100%collateralized).

A further embodiment of the present invention is illustrated in FIG. 3.This comprises a note instrument 70 that has an investment principal 72(which constitutes an actual investment, not only a deposit ofcollateral and, accordingly, cannot have a notional component). Theinvestment principal 72 may be any financial instrument, e.g., stocks,bonds, T-bills, cash, currencies, mortgages, any other security, or acombination thereof. The note instrument 70 includes a performancecomponent, which at the beginning of an initial time period comprises abase portfolio exposure 74 together with a passive, long and short,commodity index exposure 76. The amount of the base portfolio exposure74 is identified by the term P_(B1), which is substantially equal to theamount of the investment principal 72.

The amount of the passive commodity index exposure 76 is a product of aleverage factor L₁ and the exposure P_(B1). For the note instrument 70,a different formula is used for calculating the value of the leveragefactor than is used in the case of the swap instrument 20. The preferredleverage factors are as low as 200% or as high as 400%. The leveragefactor is selected to be as low as 200% if the performance over thepreceding 12 months (or other period of time) of the selected commodityindex equaled or exceeded 15%. This is the case for the MLM under marketconditions in late 1998. Using a different commodity index and/or underdifferent market conditions, this 15% figure could vary. If the totalrate of return was less than 15%, a leverage factor of as high as 400%is selected. Thus, depending upon the performance of the referencedcommodity index over the preceding 12 months (or other period of time),the amount of the exposure 76 is either as low as two or as high as fourtimes the amount of the base portfolio exposure 74. These are preferredleverage factors, but other leverage factors may also be used.

The note instrument 70 has a defined period to maturity, often as longas 10 years. However, the leverage factor applicable to the commodityindex component (as low as 200% or as high as 400%) may be adjustedperiodically while the note is outstanding (typically as of eachanniversary of the note's issuance). Upon the expiration of the timeperiod 78 between leverage adjustments if any, the performance componenthas a final value which comprises a base portfolio exposure 84 having avalue of P_(B2) and a passive long and short commodity index exposure 86having a value P_(C2).

At the end of the time period 78, the base portfolio exposure 74 hasexperienced, on a notional basis, notional index (NI) change 81, whichis represented as ΔV_(B1), and the commodity index exposure 76 has anotional index (NI) change 83 which is represented as ΔV_(C1).

A fundamental aspect of the note instrument 70 is that there is aguaranteed return to the investor of the investment principal 72 at thematurity date of the note. As a result of this guarantee, the investoragrees to accept less than the full notional index (NI) change in valueof the base portfolio exposure and of the passive, long and short,commodity index exposure.

The notional changes to the base portfolio and the commodity indexportfolio exposures is adjusted by a payout factor, which typically is anumber less than one, in determining the return recognized by the noteon these portfolios. This is due to the fact that it would not beeconomically feasible for the note issuer to hedge the full return onthe notional base portfolio and commodity portfolio exposures and stillguarantee the return of the note's full investment principal at thematurity date. An example of such a payout factor (which would in facthave been the payout factor in late 1998 based on then current marketvolatility levels—the payout factor reflects hedging costs whichgenerally increase with volatility) is 40%, also expressed as 0.4.Application of the payout factor, such as 40%, results in a payoutfactor adjustment to produce a payout value 92 that is a product of thenotional index change 81 and the payout factor. Likewise, there is apayout value 94 which is the product of the 0.4 payout factor and thenotional index change 83. The payout factor on both the base portfolioand the passive, long and short, commodity index portfolio is the sameand does not change throughout the lifetime of the note. The notionalindex changes 81 and 83 have no direct effect on the value of the note.Only payout adjusted value changes 92 and 94 are reflected in the note'snet asset value. The total return to the investor, if the noteinstrument 70 is terminated at the end of the time period 78, comprisesthe investment principal 72 together with the payout value 92 and payoutvalue 94 (unlike the swap instrument 20, no interest accrues to theinvestor on the investment principal of the note instrument 70; thisprincipal, as in the case of any note, is paid to the issuer of the noteand becomes the property of the issuer; it does not remain the propertyof the investor; if interest is earned on this principal, it belongs tothe issuer, not to the investor). The total payout can be expressed asthe sum of ΔV_(BP1) and ΔV_(CP1).

The payout factor is a function of the leverage. If the leverage isselected to be relatively low, the payout factor can be greater thanone.

In addition, while the note instrument 70 can be releveraged each year,it is not rebalanced. The base portfolio and the passive commodity indexcomponents, separately, increase or decrease during each year. Theperformance of the base portfolio, cumulating year-to-year, determines,as of each anniversary (or other period) of the note's issuance, thebase portfolio exposure for the subsequent year (or other period); theperformance of the passive commodity index portfolio cumulatingyear-to-year, determines, as of each anniversary (or other period) ofthe note's issuance, the passive commodity portfolio unit to which thereleveraging formula is then applied as of the beginning of each year(or other period).

The final performance base portfolio exposure 84 comprises a baseportfolio exposure 84 a, and a value change 84 b which is equal to thepayout value change 92—i.e., notional index change 81 multiplied by thepayout factor. A final commodity index exposure 86 comprises a passivecommodity exposure 86 a, which is equal to the commodity index exposure76, and a value change 86 b, which is equal to the payout value change94—i.e., notional index change 83 multiplied by the payout factor.

In a typical case, the note 70 will have a multiple year duration, forexample 10 years. However, at the end of a shorter period, such as oneyear, the investment note 70 can be releveraged as shown in FIG. 4 wherethe note is referenced as instrument 70′. The leverage factor applied tothe commodity index portfolio component of the note 70 can be fixed forthe duration of the note, however, as an option, the leverage may bechanged on a periodic basis, such as yearly. The illustration in FIG. 4represents the releveraging of the commodity index exposure of the note20 at the end of the first year (or other period) and the start of thesecond year (or other period) after the note's issuance. At the end ofthe first year (or other period) the value of the base portfolio, asshown by the base portfolio exposure 84, is represented by the valueP_(B2). At the end of the first year (or other period) the commodityindex exposure has resulted in a value represented by P_(C2). The note70′ is releveraged by changing the leverage factor for the commodityindex exposure. There is no leveraging adjustment made to the baseportfolio exposure 84. The releveraged commodity index exposure is shownby reference numeral 102.

The releveraging to produce the commodity index exposure 102 is effectedusing the same formula utilized initially to determine the leveragefactor for the commodity index exposure 76, as described above inreference to FIG. 3. The ending value of the passive commodity indexportfolio 86 is divided by the leveraging factor used in the prior year(or other period) to calculate a “unit” of passive commodity indexexposure. That unit is then multiplied by the new leverage factor,determined as previously described, to establish the commodity indexportfolio exposure for the new year (or other period) represented byexposure 102. For the present example, the initial leveraging factorapplied to the commodity index exposure 76 is referenced as L₁, whichmay be assumed to be 200%. If the newly calculated leverage factor L₂ isassumed to be 400%, then the passive commodity index exposure 102 willbe twice as large as the passive commodity index exposure 86 and alsogreater than the initial passive commodity index exposure of 76 (barringa greater than 50% loss in the passive, long and short, commodity indexexposure in time period 78). The value (P_(C3)) of the commodity indexexposure 102 is determined by the formula P_(C3)=(P_(C2)÷L₁×L₂). If L₁and L₂ are respectively 200% and 400%, then the value P_(C3) will be2×P_(C2). Should the original value of L₁ be 400% and L₂ is 200%, thenP_(C3) will be 0.5% of P_(C2). P_(C2) reflects the performance of thepassive commodity index portfolio in the time period 78. Alternatively,the new leveraging factor L₂ can be applied to the sum (P_(B1)+86_(b))rather than to (P_(C2)÷L₁).

Upon expiration of the second time period 104, there is a notional indexchange 106 (ΔV_(B2)) in the base portfolio exposure 84 and a notionalindex change 108 (ΔV_(C2)) in the commodity portfolio exposure 102.These notional index changes are adjusted by a payout factor (40%) toyield a payout adjusted value change 110 (ΔV_(BP2)) and a payoutadjusted value change 112 (ΔV_(CP2)).

After the expiration of the time period 104, the second time period,there is produced a final base portfolio exposure 114 having a basiccomponent 114 a and a value change 114 b equal to the payout adjustedchange in value 110 for the base exposure, which is represented by theterm ΔV_(BP2). Likewise, following the completion of time period 104,there is produced a final passive, long and short, commodity indexexposure 116 having a basic component 116 a and a value change equal tothe payout adjusted change in value 112 for the commodity indexexposure, which is represented by the term ΔV_(PC2).

The return to the investor equals ΔV_(BP2) plus ΔV_(CP2).

The leverage factor applied to generate the commodity index exposure 102can be constant, the same as was applied to generate commodity indexexposure 76, or it can be the result of the changes in the leveragefactor effected periodically over the life of the note instrument 70′with releveraging performed as described above in reference to FIG. 4.

A numerical example for the note instrument 70 as shown in FIGS. 3 and 4is now presented. In this example, the investment principal 72 is $10million. Therefore, the base portfolio exposure 74 has a value of $10million. For this present example, the leverage factor L₁ is assumed tobe in the lowest mode of 200%. Thus, the passive commodity indexexposure 76 is $20 million. If during the time period 78, the passivecommodity index exposure 76 increases to $30 million, the notional indexchange 83 would be $10 million and the payout adjusted value change,i.e., the return to the investor would be $10 million multiplied by thepayout factor, which is assumed to be 40%. This would result in a valueof the commodity index exposure 86 of $20 million plus $4 million for atotal of $24 million.

If during the time period 78 the notional base portfolio exposure 74increased to $12 million, the notional index change 81 would be $2million and the return to the investor would be $2 million multiplied bythe payout factor which is assumed to be 40%. This would result in avalue of the base portfolio exposure 84 of $10 million plus $8 millionfor a total of $10.8 million.

Based on the results in time period 1 (78), $10.8 million would be thevalue of the base portfolio exposure 84. No leveraging adjustment wouldbe made to this base portfolio. The commodity index exposure 86 as ofthe end of time period 1, an amount of $24 million, would be subject toa leveraging adjustment depending on the performance of the commodityindex during the preceding 12 months (or other period of time). If thepositive change in this index equaled or exceeded 15% during thepreceding 12 months (or other period of time), L₁ (the lowest leveragefactor) would again be applied and the commodity index exposure wouldremain at $24 million (alternatively, this leveraging factor could beapplied to the sum (P_(B1)+86_(b)), i.e., ($10 million+$4 million), fora P_(C3) value of $28 million. If, however, the positive change in thecommodity index was less than 15% during the preceding 12 months (orother period of time), L₂ (the high leverage factor) would be applied.Accordingly, the commodity index exposure 86 at the end of time period1, an amount of $24 million, would be divided by L₁ (200%) to determinethe notional value of a “unit” of commodity index leverage. This unitwas initially equal to the base portfolio exposure 74, and during timeperiod 78 the total commodity index exposure 76 was 2 units of commodityindex leverage, as L₁ equaled 200%. In order to determine the value ofthis unit as of the beginning of time period 104, the commodity indexexposure 86 is divided by the L₁ leveraging factor initially applied tothe initial unit of commodity index exposure (equal to the baseportfolio 74). The result, ($24 million÷2) or $12 million, is thenmultiplied by the new leveraging factor L₂ (400%) to generate a newcommodity index exposure 102 of $48 million. Alternatively, thisleveraging factor could be applied to the sum (P_(B1)+86_(b)) i.e., theinitial unit of commodity index exposure plus ΔV_(CP2), to generate anew commodity index exposure of $56 million.

If during time period 104, the passive commodity index exposure 102increases to $60 million, the notional index change 108 would be $12million and the payout adjusted value change 112 would be $4.8 million.This would result in a commodity index exposure 116 of $52.8 million. Ifduring time period 104, the notional base portfolio exposure 84increased to $15 million, the notional index change 106 would equal $4.2million and the return to the investor would be $4.2 million multipliedby the payout factor which is assumed to be 40%. This would result in avalue of the base portfolio exposure 114 of $10.8 million plus $1.68million for a total of $12.48 million.

The note instrument of the present invention comprises a combination ofa base portfolio, preferably keyed to an equity index (which in thepreferred embodiment is the S&P), and a passive, long and short,commodity index (which in the preferred embodiment is the MLM). Selectedleverage factors for the MLM with respect to the base portfolio are aslow as 200% and as high as 400%. Other leverage factors, as well asother means of releveraging the two portfolios can also be applied. Thediversification features of a unitary note instrument with these twoleverage factors using the S&P and MLM indices is illustrated below inTable 2.

TABLE 2 NOTE INSTRUMENT MARKET SECTOR ALLOCATIONS (Percentages Are ofTotal Portfolio Exposure) S&P (Base Portfolio) Equities 33.33% 20.0% MLMPassive, Long and Short, Commodity Index Portfolio) 200% Leverage 400%Leverage Bonds 8.00% 9.6% Currencies 16.60% 19.2% Energy 10.67% 12.8%Grains 13.33% 16.0% Other Agriculture 10.07% 12.8% Metals 8.00% 9.6%100.00% 100.0%

The investments of the present invention differ from most alternativeinvestments in that they provide total trade transparency to theinvestors. At any given time, the investors holding these instrumentsnot only know what underlying positions are currently held as componentsof their investment instruments, but also what positions will be helduntil the end of the current calendar month, when the MLM internallyrebalances its positions.

The swap instrument periodically rebalances its base portfolio exposureto an amount equal to the initial base portfolio exposure adjusted forperformance since inception. The swap instrument then re-establishes itspassive commodity index exposure by applying the appropriate leveragefactor, as determined by the performance of the commodity index over thepreceding 12 months (or other period of time), to this rebalanced baseportfolio exposure.

The note instrument's base portfolio and passive commodity indexportfolio exposure are not rebalanced, but simply reflect theperformance of each such portfolio, considered separately, sinceinception. Because of the note instrument's guarantee of the return ofinvestment principal as of the maturity date, it would not beeconomically feasible for the note issuer to hedge the risk ofrebalanced portfolios.

Both the swap and the note instrument can be periodically releveraged interms of the relative exposure of the overall instrument to its base andpassive commodity index portfolios.

A reporting and accounting system can provide daily and intra-daytrading positions and net asset value information directly to investors,as well as calculating all fees embedded in the investment instruments.Moreover, as will be recognized by those skilled in the art, computersand computer systems and the associated software currently used in theinvestment, banking and trading industries can be adapted to create,designs manage, monitor, trade, report and otherwise implement thefinancial investments, instruments and methods described herein withoutthe need for undue experimentation.

It is not necessary that the investor acquire the “base portfolio”component of the investment instrument as part of the instrument itself.The base portfolio may comprise a pre-existing portfolio held by aninvestor and may be any financial instrument, e.g., stocks, bonds,T-bills, cash, currencies, mortgages, any other security, or acombination thereof. Furthermore, an investor need not maintain a staticbase portfolio during the term of the investment instrument. Changingthe make-up of the base portfolio will affect the overall resultsachieved, but this is not inconsistent with the invention.

The investment instruments of the present invention may be evaluated byportfolio managers as internally diversified, stand-alone investments aswell as in terms of constituting non-traditional investment alternativesproviding the potential for diversifying a traditional portfolio.

The parties involved in structuring the note and swap instruments,marketing these instruments, managing the rebalancing and releveragingprocesses, monitoring net asset values, negotiating and structuring theoptional put protection available in the case of the swap instrument andissuing the swap and note instruments will receive a variety of feesfrom the investors. In certain cases, these fees will be paid directlyby investors, outside of their investment in an instrument; in othercases, these fees will be deducted from the amount invested. These feesmay include percentage fees based on the notional exposure of aninstrument, or on the commodity index component thereof, as well aspercentage fees based on the actual Net Asset Value of the instrument.Percentage fees may generally be assumed to range up to 3% per annum intotal, but will vary on a case-by-case basis. Incentive fees based onthe performance of an instrument, calculated either periodically or overthe entire term of the investment, may also be charged. These fees maygenerally be assumed to range from 15%-25%, but will vary on acase-by-case basis. There will also be a monthly charge to reflect theissuer's costs of adjusting its hedges to reflect the monthly internalrebalancing of the MLM by executing the corresponding trades in thefutures markets. A licensing fee of approximately 0.5 of 1% per annum isalso payable for the use of the MLM, and, in the case of the noteinstrument, there is an indirect cost in the form of the loss of anyinterest earned on the investment principal (investors being guaranteedonly the return of their principal, not any interest, as of the maturitydate).

All fees and charges are subject to individual negotiation, as well asin the case of certain fees, to market conditions at the time aninstrument is issued. For example, the monthly charge reflecting thehedging costs associated with the MLM's internal rebalancing as well asthe payout factor are both directly affected by market volatility.

Although several embodiments of the invention have been illustrated inthe accompanying drawings and described in the foregoing DetailedDescription, it will be understood that the invention is not limited tothe embodiments disclosed, but is capable of numerous rearrangements,modifications and substitutions without departing from the scope of theinvention.

1. A computer implemented investment system comprising: a processor anda memory, wherein the memory contains computer readable instructionswhich cause the processor to create, monitor and calculate a return foran investment product; and the investment product comprising: apredetermined time period for holding the investment product, a baseportfolio of assets having a base portfolio exposure, a leverageportfolio comprising a passive commodity index portfolio, of long andshort positions, having a passive commodity index portfolio exposure inan amount substantially equal to the base portfolio exposure multipliedby a leverage factor of at least 100%, wherein the base portfoliocombined with the leverage portfolio that reduces the risk whileincreasing the return of the investment product as compared to the baseportfolio alone, and the return comprising substantially the change invalue of the base portfolio exposure and the passive commodity indexportfolio exposure over the predetermined time period.
 2. The computerimplemented investment system as recited in claim 1, wherein theinvestment product further comprises a collateral deposit.
 3. Thecomputer implemented investment system as recited in claim 2 wherein thebase portfolio exposure is substantially equal in value to thecollateral deposit.
 4. The computer implemented investment system asrecited in claim 2 wherein the base portfolio of assets has a notionalcomponent, and wherein the value of the base portfolio exposure isgreater than the value of the collateral deposit.
 5. The computerimplemented investment system as recited in claim 1, wherein theinvestment product further comprises: a rebalanced base portfolio ofassets having an exposure in an amount substantially equal to the sum ofthe base portfolio exposure and the changes in value of the baseportfolio exposure and of the passive commodity index portfolioexposure; and a releveraged passive commodity index portfolio, of longand short positions, having an exposure in an amount substantially equalto the product of the rebalanced base portfolio exposure multiplied by asecond leverage factor.
 6. The computer implemented investment system asrecited in claim 5 wherein the second leverage factor is a function ofthe performance of the passive commodity index portfolio over a selectedperiod of time.
 7. The computer implemented investment system as recitedin claim, wherein the investment product further comprises a losslimitation which limits the maximum loss an investor can incur as aresult of a change in value of the passive commodity index portfolioexposure.
 8. The computer implemented investment system as recited inclaim 7 wherein the loss limitation is a put option.
 9. The computerimplemented investment system as recited in claim 1, wherein theinvestment product further comprises: a rebalanced base portfolioexposure to replace the base portfolio exposure; and a releveragedpassive commodity index portfolio exposure, of long and short,positions, to replace the passive commodity index portfolio exposure.10. The computer implemented investment system as recited in claim 1wherein the base portfolio is keyed to an equity index.
 11. The computerimplemented investment system as recited in claim 10 wherein the equityindex comprises the S & P 500 Stock Index.
 12. The computer implementedinvestment system as recited in claim 1 wherein the base portfoliocomprises a pre-existing portfolio held by the investor.
 13. Thecomputer implemented investment system product as recited in claim 12wherein the base portfolio comprises stocks, bonds, T-bills, cash,currencies, mortgages, any other security, or a combination thereof. 14.The computer implemented investment system as recited in claim 1 whereinthe passive commodity index portfolio is keyed to the S&P DiversifiedTrends Indicator.
 15. The computer implemented investment system asrecited in claim 1 wherein the passive commodity index portfolioincludes bonds and currencies.
 16. The computer implemented investmentsystem as recited in claim 1 wherein the leverage factor is a functionof the performance of the passive commodity index portfolio over aselected period of time.
 17. The computer implemented investment systemas recited in claim 1 wherein the leverage factor is a firstpredetermined number if the passive commodity index portfolio has had anactual return that is equal or greater than a specified return over aselected period of time and a second predetermined number if the passivecommodity index portfolio has had the actual return that is less thanthe specified return said the selected period of time.
 18. The computerimplemented investment system as recited in claim 17 wherein the firstpredetermined number is 300% and the second predetermined number is150%.
 19. The computer implemented investment system as recited in claim17, wherein the first predetermined number is at least 100% and thesecond predetermined number is greater than the first predeterminednumber.
 20. The computer implemented investment system as recited inclaim 1 wherein the leverage factor is less than or equal to 150%. 21.The computer implemented investment system as recited in claim 1 whereinthe leverage factor is less than or equal to 300%.
 22. A computeradapted to manage an investment product comprising: a computer; datastored on the computer that corresponds to the investment product; thecomputer implemented investment product comprising (a) predeterminedtime period for holding the investment, (b) a base portfolio of assetshaving a base portfolio exposure, (c) a leverage portfolio comprising apassive commodity index portfolio, of long and short positions, having apassive commodity index portfolio exposure in an amount substantiallyequal to the base portfolio exposure multiplied by a leverage factor ofat least 100%, and (d) a return comprising substantially the change invalue of the base portfolio exposure and the passive commodity indexportfolio exposure over the predetermined time period; wherein the baseportfolio combined with the leverage portfolio reduces the risk whileincreasing the return of the investment product as compared to the baseportfolio alone; wherein the computer monitors the base portfolio andthe passive commodity index portfolio, calculates the return andprovides the return to an investor.